The Great Industrial Wall of China

On a flight to Beijing, my seatmate turned out to be a corporate counsel for a major U.S. manufacturer. He was leading the negotiations for the company's entrance into a significant sector of the Chinese economy. Surprisingly, he acknowledged that his company's intellectual property would eventually be lost as a result of the deal, through technology transfer, reverse engineering, or flat-out theft. He knew that the company's crown jewels were going to be taken no matter what protections he negotiated. Still, he worked diligently to close the deal. He had the assistance of the U.S. government in pushing the transaction and the support of the Chinese government in backing it. The deal would be a short-term gain but a long-term risk to his company and the U.S. economy, and it would utterly exclude the people not at the bargaining table: the American workers whose jobs would be lost to China.

A wide variety of financial incentives offered by Chinese government authorities to U.S. companies prove irresistible to business people like my seatmate, despite the many dangers of investing in China. No wonder my seatmate admitted that he lies awake at night thinking about his children's economic future.

China is not a free-market economy, but it is a very effective one. Despite the economic orthodoxy that subsidies, protectionism, and central government economic planning create inefficiencies and hobble growth, it is hard to argue with 30 years of success by Beijing's economic technocrats and their authoritarian masters.

Much of China's success is due to its willingness to cheat while most other nations, including the United States, faithfully adhere to most of the rules established by international organizations such as the World Trade Organization and the International Monetary Fund. China is blatantly protectionist. In order to provide an advantage for Chinese industries and companies, and to attract U.S. companies to locate in its country, the Beijing government manipulates its currency, showers subsidies on favored industries, provides low-interest loans from a state-owned banking system, tolerates and even encourages the theft of intellectual property, and ignores WTO rules.

The Chinese government has a centralized planning process, through which it identifies a strategy for supporting pillar industries within China while creating so-called national champions to compete abroad. Many of the industries are in basic manufacturing sectors where neglected U.S. industries, such as textiles and apparel, furniture, and machine tools, have been allowed to wither away. Much of the Chinese economy, including the aviation, shipping, oil, electricity, and telecommunications sectors, is still owned or controlled by the Chinese government. And the government maintains strict control over other key industries, including automotive, information technology, construction, and steel.

The Chinese government wields all the tools at its disposal to support and protect its national champions. For example, the Chinese government controls the price of gasoline and diesel fuel and provides special discounts to favored industries, such as transportation and fishing. It seizes farm land and turns it over to favored industries without adequate compensation to the farmers. It allows companies to underpay workers and refuses to allow them to organize independent labor unions. When under international pressure, China may remove one trade barrier, only to replace it with another. So, when the WTO ruled against the Chinese on regulations relating to local content of car parts, the Chinese sought to use environmental regulations to achieve the same ends. China rebates the value-added tax on some exports, which is allowed by WTO rules, but it selects which taxes to rebate, which is not.

China controls or threatens to control access to raw materials at the source. Rare earth minerals are a recent and telling example. China controls the production of over 90 percent of these minerals, much of it in China. Over the past 15 years, China has also acquired or tried to acquire the few sources of these critical materials outside China. Rare earth minerals are necessary components in electrical engines for hybrid cars, plasma screens, hard drives, magnets, and other consumer products. They are also critical to some defense technologies. If China cuts exports of rare earth minerals, it will be protecting and promoting its own related industries, including green technologies, at the expense of foreign companies.

The Obama administration has identified green technology as a sector critical to our future economic growth. But the Chinese have turned the full force of their economic planning on this same sector, so we have been falling behind before we even get started. China has already built the world's largest solar-panel manufacturing industry, exporting over 95 percent of its output to the United States and Europe. While the Chinese government was criticizing the modest "buy American" provisions in the U.S. stimulus package, it required that at least 80 percent of the equipment for its first solar plant be made in China. The Chinese government ensured that Chinese domestic companies won the bids this spring for 25 large contracts to supply wind turbines. The bids of all six multinational companies for those contracts were disqualified on various technical grounds.

Despite repeated promises, the Chinese government has refused to sign on to the government procurement agreement, which would prohibit favoritism to domestic companies. Since 2001, the Chinese government has committed annually to join the GPA as soon as possible. At the Joint Commission on Commerce and Trade meeting in October, the annual trade-focused gathering between high-level U.S. and Chinese trade and commerce officials, the Chinese promised yet again that they would do something on this front in 2010.

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In July 2009, the U.S.?China Economic and Security Review Commission, an organization created in 2000 by Congress and assigned to study the national-security implications of the U.S.?China economic relationship, held a hearing in upstate New York. As chair of the commission, I endorsed Rochester for the venue because its existing manufacturing, research and development, and skilled-worker base positions the city as a U.S. center for green innovation. But the hour is very late.

We found that, on green technologies, the Chinese government has already adopted the predatory practices it has honed to a fine art in other industries. Much of the research and development as well as engineering on green technology -- the engine for innovation -- are moving to China to co-locate with the green-technology manufacturing that is already there. The technology now being developed in China includes solar panels, advanced batteries, LEDs, lasers, wind turbines, infrared, and sensors.

The Chinese government is offering extensive subsidies to the world's green-technology manufacturers to encourage them to move production to China. And when the manufacturing leaves America, the research-and-development operations are sure to follow. After all, the manufacturers want their researchers and engineers on-site to work out problems and suggest work-arounds. This one-two punch has been a successful strategy for China in the automotive sector where battery and fuel-cell research formerly conducted in America is being conducted alongside auto assembly lines in China.

The Chinese government has been applying the same strategy to the aerospace sector. For example, on Nov. 14, General Electric announced a new technology joint venture with AVIC, the Chinese state-owned aviation company, to develop and market integrated avionics systems for commercial aircraft customers. The press release noted that "the new avionics company, to be headquartered in China ... will build on [GE's] extensive avionics capabilities and its China Technology Center in Shanghai to create a technology center of excellence to serve the commercial aviation market." AVIC's vice president, Zhang Xinguo, said in the same release, "The joint venture is based in China but will target the U.S. and the global market."

The Chinese government is a master of opacity in many facets of its work. We have little insight into Chinese military spending, for example, or into the internal workings of the Chinese Communist Party. In economic planning, however, there is no big secret. The Chinese government is open about its economic plans and has been for decades. The 11th Five Year Plan, under which it is now working, is a detailed blueprint for economic growth. Despite the global economic crisis, the blueprint is being followed.

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Knowing what we know of the Chinese economic plan, why haven't we acted to counter it?

The simple answer: U.S.?China policy has, over the past two decades, been driven by the interests of the multinational corporations, and those global firms have benefited from many of China's policies. Starting several decades ago, it was a handful of the exporting elite -- Boeing, Motorola, and GE among them -- who argued persuasively to the Bush, Clinton, and Bush administrations that U.S. economic interests would be served if only these companies had access to the Chinese consumer. The implication was that the American worker would benefit because production here in the United States would increase as the Chinese consumer bought American products. Then, as more and more companies signed on, and the investment banks got involved, production shifted to China. Our trade deficit with China soared from over $2 billion at the time of Tiananmen Square in June 1989 to $268 billion in 2008. The cumulative trade deficit with China over the past 20 years? Two trillion dollars.

Instead of adjusting our trade and economic policy, U.S. policy-makers adjusted the rationale for the continuation of a status quo that was failing the American worker. Of the estimated 1.94 million U.S. jobs lost to China since China's economic reforms started 30 years ago, 1.05 million of them -- over half -- were lost since China acceded to the WTO in 2001. Yet in 2004, Greg Mankiw, then chair of President George W. Bush's Council of Economic Advisers, said that outsourcing American jobs was good for the economy. Perhaps he believed that those people who lost their jobs could make up the difference in income by day trading their severance payments and unemployment benefits on the stock market. Today, of course, we see the result of that sort of thinking. With the global economic crisis, American workers have ended up without jobs and without pension funds.

The Chinese government has been masterful in playing companies off each other. Beijing threatened to buy Airbus planes instead of Boeing aircraft every time Congress was about to vote on what was then called "most favored nation" trade status, giving China the same rights as other trading nations even though China's behavior remains predatory. China has been masterful in coercing technology transfer from U.S. companies as it built its targeted industrial sectors. And it continues to employ a broad array of levers to build its economy -- incentives such as a choice spot in one of the many vast, subsidized research-and-development industrial parks.

U.S. policy-makers have never adjusted, perhaps because it is so difficult to admit that the foundations on which decades of policy have been built -- free trade, financial-services deregulation, and repeated tax cuts in the face of rising deficits -- are flawed. Perhaps they cannot grasp that the advantages of free-market capitalism are being trounced by a centrally controlled Leninist capitalism that flouts the international trade rules with abandon. Perhaps they cannot accept that English economist David Ricardo's early 19th-century theory of comparative advantage might no longer hold true. Perhaps many in government now serve with one eye on their post-service employment in the private sector. Or perhaps campaign-finance laws give the leverage to American corporations rather than to American workers. Most likely, it is a combination of all of these factors.

Government officials and the private sector working together on issues connected with China have come up with "innovative" ideas that benefit corporate America but perplex working Americans and their champions. One of those recent ideas was a proposal to use stimulus funds to develop a joint U.S.?China venture wind-power farm in West Texas. These taxpayer-provided funds would have created more than 2,000 manufacturing jobs in China and, according to TheNew York Times, slightly over 300 in Texas. To add insult to injury, the stimulus program is funded with borrowed money, much of which has been provided by the Chinese government. So, we would be increasing the debt load on the American worker while ensuring that Chinese workers got jobs in industries in which we are vying to be leaders.

It is clear that action must be taken to address the hazards of global climate change. It is also clear that the United States and China must cooperate on the effort. What is less clear is why U.S. workers should be expected to foot the bill, particularly when China has foreign currency reserves of $2.3 trillion.

The danger is that U.S. business interests in China may be manipulating the cooperation process to support the transfer of more jobs from the U.S. to China. For example, a new Energy Cooperation Program (ECP), "a public-private partnership focused on commercialization of clean energy solutions" according to the office of the U.S. trade representative, was launched in October as part of "an ongoing partnership among the Departments of Commerce and Energy, [the Trade and Development Agency], and U.S. industry with respective Chinese counterparts."

According to the American Chamber of Commerce?China, the ECP is based on AmCham China's Aviation Cooperation Program and "will draw upon the expertise of AmCham?China members and U.S. companies in partnership with Chinese entities to help develop clean energy solutions in China." Similarly, the Aviation Cooperation Program "provides a platform for U.S. aviation companies and the government to work closer together to support the fast growing China market." Take away the self-congratulation, and you are left with the simple fact that the U.S. government, at the behest of China-based multinationals, is spending tax dollars to move production and jobs to China.

Cooperation has a nice ring to it. But we need a new partnership among American corporations, workers, and officials -- a partnership that puts the interests of the American economy and American workers first. At home, we need a national economic, innovation, and industrial strategy. The Chinese government has one and it works. If we continue to resist developing a national plan, we are practicing unilateral disarmament to the detriment of our economic future.

And internationally, we need to strengthen the trade mechanisms that already exist. Then we need to bring new cases challenging Chinese subsidies and mercantilist practices. Unfortunately, some of the existing WTO mechanisms can now be characterized as too little, too late. Cases taken to the WTO are narrowly decided, in secret, without the benefit of precedent. The cases are allowed to drag on for years. By the time action has been taken, the damage is often already done.

Further, we need to stop dancing around the Chinese government's unfair monetary and foreign-exchange practices. The Obama administration could begin by making an honest statement noting that China has gained an enormous trade advantage by manipulating its currency, in contravention to the rules of the WTO and the International Monetary Fund. The next step would be to bring a formal complaint to both bodies to remove this long-standing violation.

Today, the rationale for not disturbing Chinese leaders is that we must sell them ever more Treasury bonds in order to finance our growing debt. But this argument is specious. The Chinese cannot start dumping their dollar holdings without jeopardizing the value of their vast hoard, estimated to be between $800 billion and $1.7 trillion. And, as long as they continue to depend on an export-driven economic growth model based on an artificially low-value currency, they must continue to acquire and hold dollars to maintain the peg.

So, we do have a position of strength from which we can bargain. Unfortunately, President Obama's weak performance on his trip to China apparently didn't impart that message. Nor do the fearful murmurings of his economic advisers. The Chinese government has successfully buffaloed them all with the implied threat that China will sit out the next Treasury auction.

Government exists to serve the people and not just the corporations that appear so anxious to outsource the economy to China. We have a 17.5 percent real unemployment rate, a trade deficit with China of $268 billion in 2008, and a gross domestic product expected to decline by 2.7 percent in 2009. China's official unemployment rate is only around 5 percent, it had a global trade surplus of $290 billion in 2008, and its accumulated foreign-currency reserves now total $2.3 trillion. Its GDP is expected to grow by 8.5 percent for the year.

At the behest of U.S.?based multinationals, Washington has championed the causes of corporate interests masquerading as free trade. But, free markets and free trade work only when everyone follows the rules. China doesn't, and as the third largest economy in the world, its rule-breaking is capturing market-share and industrial leadership from everyone else. For the sake of American workers, and the economic future of my seatmate's children, this must change.

About the Author

Carolyn Bartholomew chairs the U.S.?China Economic and Security Review Commission, but the views expressed in this article are her own.